Gold overreacts to QE3 ending soon

The U.S. Comex gold futures traded in a wide range from $1,661.20 to $1,695.40 in the first two trading days of the year. After jumping almost 2% in the first half of the week, the gold futures dropped 0.84% on Wednesday, and fell almost 1.50% during the first three hours of Asian trading on Thursday. The S&P 500 Index rose 4.06% this week while the Euro Stoxx 50 Index rose 2.83%. The Dollar Index exceeded 80 again, rebounding 0.81% in the past two days.

Decent Global Economic Tone

Economic data from the major countries have been showing some improvement. The China December non-manufacturing PMI index rose at the fastest pace in four months. The number of people out of work in Germany rose by 3,000, lower than the 10,000 expected in December. In the U.S., ADP employment grew 215,000 in December, higher than the 140,000 forecasted.

Fear of QE3 Ending Sooner Than Expected

However, gold, stocks and bond prices plunged on Thursday after the release of the December FOMC minutes, which revealed that QE3 could end this year. The tone seems to be a bit different from that in the Dec. 11-12 FOMC meeting when Ben Bernanke announced the linkage between the interest rate level and the numeric targets of unemployment rate and inflation. Given the current unemployment rate is still well above the 6.5% threshold, it is unlikely for the Fed to end the QE3 anytime soon. Other governments are still stimulating their economies. Japan will likely increase its inflation rate by increasing asset purchases while adding to fiscal stimulus. China plans to increase infrastructure spending and sustain loan growth.

Rising Structural Demand for Gold

Other structural changes can support gold prices. In the Basel III, gold has been re-rated from a Tier-3 asset to a Tier-1 asset, or "zero-risk" collateral. This means that banks can decide to buy gold instead of sovereign bonds to fulfill the rise in the Tier 1 asset requirement. The Shanghai Gold Exchange has just started a trial on gold inter-bank trading to increase the liquidity and flow of gold in China.

Events to Watch Next Week

Important events will include the China industrial production growth in December on Jan. 9, and the ECB interest rate announcement and the Bank of England monetary policy decision on Jan. 10.